Special Economic Zones: Boon or bane for emerging country firms?
Pune, Maharashtra, India. (Image: onkar gotale via Unsplash)

Special Economic Zones: Boon or bane for emerging country firms?

An industrial policy measure to attract foreign investment to the private sector.

By Holger Görg and Alina Mulyukova

To enable firms to participate in the globalization process, governments in emerging economies may opt to implement policies aimed at increasing their countries’ attractiveness to foreign investors. One frequently used industrial policy measure in many emerging economies is the establishment of so-called Special Economic Zones (SEZs). These are geographically delineated areas within which governments promote industrial activity through infrastructure investment and fiscal and special regulatory incentives with the aim of attracting investments. There are currently an estimated 4,300 SEZs worldwide which account for at least 20 per cent of global trade1.

Motivated by the success of SEZs in China2, India’s government announced the launch of the “SEZs Act” in 2005. The Act promotes the establishment of SEZs in the private sector by providing for high-quality infrastructure, attractive fiscal incentives and minimum regulation. The main objectives of establishing SEZs are (i) generating additional economic activities; (ii) promoting exports of goods and services; (iii) attracting domestic and foreign investment; (iv) creating employment opportunities, and (v) developing infrastructure facilities.

As of 2020, there were 354 notified SEZs in India, of which 262 were operational. SEZs are clustered in districts around the coast and are predominantly located in the southern part of the country (figure below), which is not surprising given the access to ports and well-developed infrastructure. Interestingly, there is also a within-district clustering of SEZs, i.e. up to 44 SEZs are concentrated in one district, while other districts have none.

List of registered SEZs in India - by district

Special Economic Zones: Boon or bane for emerging country firms?
Source: List of registered SEZs set up under the 2005 SEZs Act, Ministry of Commerce and Industry, Department of Commerce.

Do domestic firms benefit from SEZs?

In our study3, we examined the impact of SEZs on Indian firms’ productivity growth and other performance measures. We distinguished between two types of firms, namely those located inside an SEZ and those located in the vicinity of an SEZ. This allowed us to differentiate between direct effects on ‘insider’ firms and spillover effects on ’outsider’ firms. Using geocoded data and information on the total land area of the SEZs, we created spatial rings of different radiuses around the SEZ centres (Figure 2). The SEZs’ original size is the smallest of the circles which is called ring inside. It is created using information on the land area of SEZ. The radius of each outer ring is increased by five kilometres to create the following distance bands: (i) inside the ring; (ii) 0–5km; (iii) 5–10km, and (iv) 10–15km. To evaluate the impact of SEZs on firms, we compared the performance of firms before and after the introduction of the SEZ programme in 2005 relative to a control group of similar firms located at a distance of at least 40km from an SEZ (for details on constructing a comparable control group, see the original study).

SEZ distance bands (in km)

Special Economic Zones: Boon or bane for emerging country firms?
Source: Prowess database and the List of Notified SEZs set up under 2005 SEZs Act, Ministry of Commerce and Industry, Department of Commerce.

Our results reveal that the establishment of SEZs decreased the productivity growth of firms located inside the zones by an average of 15.4 per cent. This result is primarily driven by relatively more productive firms, while less productive firms did not register any significant changes. Domestic firms, large firms, manufacturing firms and importing firms are those most adversely affected by the programme. We did not find any evidence of spillover effects.

We also found that hi-tech SEZs are relatively more productive compared to SEZs specializing in other industries. Moreover, we show that the presence of state-owned industrial development corporations as mediators for the development of an SEZ leads to only low productivity gains in practice.

There is, however, evidence of strong positive productivity growth increase for relatively large, i.e. above mean area, SEZs. This result may indicate the potential benefits of SEZs if they form a cluster and accumulate in one specific region rather than being spread out across the country.

Differences between SEZs in China and in India

What explains the stark differences between the effects of SEZs on Indian and Chinese firms? First, initial waves of Chinese SEZs targeted coastal regions with easy access to ports and transportation networks, whereas in India, no restrictions on the geographic location of SEZs have been imposed. Second, unlike China’s SEZs which are large open territories covering entire cities and spanning over hundreds of thousands of hectares, SEZs in India are fenced-in zones, the smallest being 1 hectare. Third, in India, firms submit an application to establish an SEZ, which are reviewed by the state and local governments and have to be approved by the Board of Approval. By contrast, in China, the government assigns a given area SEZ status, which attracts foreign and domestic firms due to preferential fiscal regulations.

Another likely reason for the differences in impact of SEZs on Indian and Chinese firms may be the relatively small size of India’s SEZs. The Indian SEZ programme allows private firms to develop an SEZ, i.e. SEZ status can even be assigned to a single firm in India, whereas in China, the government is responsible for assigning SEZ status and assigns such status to a specific area. Furthermore, the strategic targeting of place-based policies in China has clearly been advantageous for firms, while SEZs in India have been established in different areas across the country.

  • Holger Görg is Professor of International Economics at the University of Kiel and Head of the Research Area “Global Division of Labour” at the Kiel Institute for the World Economy. He is also Director of the Kiel Centre for Globalization (KCG).
  • Alina Mulyukova is Doctoral Researcher at the Kiel Institute for the World Economy and the Kiel Centre for Globalization (KCG).

Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).

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